Licensing of intellectual property

Licensing of intellectual property – in summary

The standard provides application guidance for the recognition of revenue attributable to a distinct licence of intellectual property (IP).

The general model is that if the licence is distinct from the other goods or services, then an entity assesses the nature of the licence to determine whether to recognise revenue allocated to the licence at a point in time or over time and to estimate variable consideration.

But with complex topics like licensing of intellectual property, there is also guidance separate from the general model for estimating variable consideration, on the recognition of sales- or usage-based royalties on licences of IP when the licence is the sole or predominant item to which the royalty relates.

What is intellectual property?

One could say almost everything could be intellectual property! Licensing of intellectual property

Here is a description (not a definition!) from the WIPO (World Intellectual Property Organisation):

Intellectual property (IP) refers to creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names and images used in commerce.

IP is in general protected in law by, for example, patents, copyright and trademarks, which enable people to earn recognition or financial benefit from what they invent or create. A difficult balance exists between striking the interests of innovators and the wider public interest, businesses operating in IP have to foster an environment in which creativity and innovation can flourish.

Just take a look at the (public) discussion between open source software (Apache OpenOffice) and licensed software (Microsoft Office365).

IFRS 15 Reporting of intellectual property

The following decision tree summarises how the IFRS 15 Reporting of intellectual property applies to licences of IP.

Licensing of intellectual property

This decision tree is further explained and addressed in the following parts. Licensing of intellectual property

Licences of intellectual property – Introduction

A licence of IP establishes a customer’s rights to the IP of another entity. Examples of IP licences include:

  • software and technology; Licensing of intellectual property
  • franchises; Licensing of intellectual property
  • patents, trademarks and copyrights;films, music and video games; and
  • scientific compounds. [IFRS 15.B52] Licensing of intellectual property

However, as noted in the first decision of the aforementioned decision tree, IP licences can be contracted offering a service or a licence, here are the two examples to make the difference: Licensing of intellectual property

Worked example – Promise is a service not a licence

Streaming Service S provides a music streaming service to customers. S enters into a one-year contract that grants Customer C a licence to access the music content via the internet on C’s personal devices. However, C does not have the ability to download the music content during the contract term and it can listen to the music only through the internet.

S evaluates whether it is providing C with a service or a licence to its content. S concludes that the contract does not include a licence because C does not have the ability to download the music during the contract term and use it without accessing S’s site.

As a result, the licence guidance does not apply.

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Worked example – Promise is a licence

Production Company P produces music content. P enters into a three-year licence agreement to provide an initial music library and rights to future content to Customer C. The terms of the licence allow C to play, stream and broadcast the content to other parties.

P evaluates whether it is providing C with a service or a licence to its content. P concludes that the contract includes a licence of IP because C takes delivery of the music library that it can use without further services from P.

As a result, the licensing guidance applies and P needs to evaluate whether the licence related to the initial music library is distinct from the rights to future content.

Here are 4 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – Different reporting for a licence and sale of IP

A licence establishes a customer’s rights to a licensor’s IP and the licensor’s obligations to provide those rights. Specific application guidance is provided for measuring and recognising revenue from licensing transactions, including guidance for recognising revenue from sales- or usage-based royalties (see Sales- or Usage-based royalties).

The accounting depends on the legal distinction between a sale and a licence of IP. If a transaction is a legal sale of IP, then it is subject to the general model in the same way as the sale of any good or other non-financial asset.

Sales- or usage-based royalties on a sale of IP are subject to the guidance on measuring variable consideration, including the constraint, and not the specific recognition guidance applicable to sales- or usage-based royalties from a licence of IP.

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Food for thought – No definition of intellectual property

The term ‘intellectual property’ is not defined in the standard, nor elsewhere in IFRS. In some cases, it will be clear that an arrangement includes a licence of IP – e.g. a trademark. In other cases – e.g. when content is being made available to a customer over the internet – it may be less clear and the accounting may be different depending on that determination. Therefore, an entity may need to apply judgement to determine whether the guidance on licences applies to an arrangement.

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Food for thought – IP that forms part of tangible asset

IP may be included in tangible products such as DVDs, hard-copy books or CDs. The first-sale doctrine, which exists in US copyright law, provides that the individual who purchases a copyrighted work from the copyright holder is the owner of that individual copy and receives the right to sell or lease that particular copy.

Generally, when IP is embedded in the tangible product the licensing guidance does not apply to the sale of goods subject to the first-sale doctrine. Instead, an entity applies the general guidance in the revenue standard to determine the transaction price and when control of the goods transfers to the customer. Non-US entities would consider similar laws and concepts to the first-sale doctrine.

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Food for thought – Distinguishing between a licence and service

Even if a contract states that the arrangement is a licence, the nature of the promise to the customer may be that of providing a service. The evaluation of whether the arrangement is a licence or a service requires judgement based on the identification of the performance obligations in the arrangement – i.e. Step 2 of the model (see Step 2 Identify the performance obligations in the contract). The guidance on determining whether a licence is distinct (see Determining whether the licence is distinct) also applies in the determination.

Is the licence distinct from non-licence goods or services?

A contract to transfer a licence to a customer may include promises to deliver other goods or services in addition to the promised licence. These promises may be specified in the contract or implied by an entity’s customary business practices [IFRS 15.B53].

Consistent with other types of contracts, an entity applies Step 2 of the model (see Step 2 Identify the performance obligations in the contract)  to identify each of the performance obligations in a contract that includes a promise to grant a licence in addition to other promised goods or services. This includes an assessment of whether the:

  • customer can benefit from the licence on its own or together with other resources that are readily available; and
  • licence is separately identifiable from other goods or services in the contract.

The basis for conclusions states that:

  • in some cases it may be necessary to consider the nature of the entity’s promise in granting a licence, even when the licence is not distinct; and
  • an entity considers the nature of its promise in granting a licence that is the primary or dominant component of a combined performance obligation [IFRS 15.BC414X].

If the licence is not distinct, then the entity recognises revenue for the single performance obligation when or as the combined goods or services are transferred to the customer. It generally applies Step 5 of the revenue model (see Step 5 Recognise revenue when or as the entity satisfies a performance obligation) to determine whether the performance obligation containing the licence is satisfied over time or at a point in time [IFRS 15.B54–B55].

The following are examples of licences that are not distinct [IFRS 15.B54].

Type of licence

Example

Licence that forms part of a tangible good and is integral to the functionality of the good

Software embedded in the operating system of a car

Licence that the customer can benefit from only in conjunction with a related service

Media content that the customer can access only via an online service

Drug compound that requires proprietary research and development (R&D) services from the entity

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Worked example – IP licence in combined performance obligation

Company X enters into a five-year patent licence with Customer Z for a fixed fee. X also provides essential consulting services for two years.

X determines that there are two promises in the contract – the patent licence and the consulting service component. However, the licence is not distinct from the service component in the contract because the services are essential and highly inter-related.

Assume that the combined performance obligation is satisfied over time – e.g. because the patent is being created for Z and will have no alternative use to X, and X has an enforceable right to payment for performance completed to date. X considers the nature of the licence to determine the period over which the combined performance obligation will be satisfied and the appropriate measure of progress to apply.

If the licence provides a right to use the IP, then the combined performance obligation is satisfied over the two-year consulting service period. In contrast, if the licence provides a right to access X’s IP, then the performance obligation will not be completely satisfied until the end of the licence term (and revenue will be recognised over the five-year licence period).

In both cases, X has to determine an appropriate measure of progress to apply over the two- or five-year performance period (e.g. time elapsed, costs incurred). For discussion of measuring progress, look here.

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Worked example – Customer’s option to purchase additional licences

Software Vendor S enters into a five-year software arrangement with Customer C. As part of the arrangement, S provides access to download copies of the software from its website. C pays a fixed fee of 300,000 for up to 200 software downloads. Each downloaded copy can have only a single user. C pays an additional 1,000 per copy downloaded in addition to the 200, pro-rated based on the remaining licence period at the time of download (e.g. 1,000 for copies downloaded in Year 1; 800 for copies downloaded in Year 2).

C receives access codes for 200 downloads on commencement of the contract. C has to request access codes for each additional download, which S will provide. S measures the number of downloads and C pays for any additional downloads each quarter.

The initial arrangement is generally a multiple licence scenario (i.e. C has been granted 200 software licences) that can be accounted for as a single performance obligation because the licences are transferred to C at the same point in time. Therefore, the option for additional downloads represents an option to acquire additional user licences to the software for 1,000 per licence.

Because the 1,000 per copy option price is less than the initial per-user licence fee of 1,500 per licence (300,000 / 200 users), S needs to evaluate whether the option provides C with a material right (see Customer options for additional goods or services).

Here are 2 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – Assessing whether a licence is distinct may require significant judgement

Licences of IP are frequently included in arrangements that include promises for other goods or services. The evaluation of whether a licence is distinct is often complex and requires assessment of the specific facts and circumstances of the contract. The standard provides the following illustrative examples that may be helpful in evaluating different fact patterns.

Type of contract

Case description

Evaluation

IFRS 15.IE49–IE58D Example 11 Case A and 11 Case B – Technology

Contract to transfer a software licence, installation services, unspecified software updates and technical support

Two cases are provided to illustrate differences in identifying performance obligations depending on whether the software will be significantly customised or modified as part of professional services also promised to the customer in the contract.

Installation services involving the customisation or modification of a software licence may result in a conclusion that the licence is not distinct from the services.

Determining whether professional services involve significant customisation or modification of the software may require significant judgement.

IFRS 15.IE278–IE280 Example 55 – Technology

Contract to license IP related to the design and production processes for a good, including updates to that IP

The customer is entitled to all updates for new designs or production processes.

The updates are essential to the customer’s ability to derive benefit from the licence.

The example concludes that the licence and the updates are inputs into a combined item for which the customer contracted and that the promises to grant the licence and the updates are not distinct.

The entity’s overall promise to the customer is to provide ongoing access to the entity’s IP.

There may be diversity in views about the kinds of technology to which the fact pattern, analysis and outcome may apply in practice.

An entity considers the nature of the promise in these fact patterns. For example, this promise is a service rather than a licence of IP with upgrades.

IFRS 15.IE281–IE288 Example 56A and 56B – Life sciences

Contract to licence patent rights to an approved drug, which is a mature product, and to manufacture the drug for the customer

Two cases are provided to illustrate differences in identifying performance obligations depending on whether the manufacturing process is unique or specialised, whether the licence can be purchased separately or whether other entities can also manufacture the drug.

Manufacturing services that can be provided by another entity are an indication that the customer can benefit from a licence on its own.

These examples highlight the potential difficulty of determining whether services and IP are, in effect, inputs into a combined item and, therefore, not separately identifiable from each other. For example, an entity may license a video game and provide additional online hosting services that are not sold on a stand-alone basis. The entity will need to determine the degree to which the service is integral to the customer’s ability to derive benefit from its rights to the video game.

The entire arrangement may be a single performance obligation or, alternatively, if the customer can derive substantial functionality from using the video game on a stand-alone basis without the additional online hosting services, then they may be separate performance obligations.

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Food for thought – Customer’s option to purchase additional licences

In some contracts, an entity charges fees for additional copies or usage of software. The entity determines whether the contract is for a single licence or multiple licences. Depending on the facts of the arrangement, the contract might contain options to purchase additional software licences that will need to be evaluated to determine whether they convey a material right to the customer or a single licence with a usage-based fee.

Judgement will be needed to determine whether an entity should apply the guidance on customer options or usage-based fees to these types of arrangements (see worked example – Customer’s option to purchase additional licences in this narrative above).

Although this type of arrangement is common for software, the same considerations apply to similar arrangements for licences of other types of IP.

Additional application examples

To further exemplify the requirements in licensing of intellectual property here some examples of application of these requirements:

Something else -   Software as a service
Worked example – Licence for drug compound and related service: Separate performance obligations

Pharma Company P enters into an arrangement with Customer C. Under the arrangement, C receives a licence for exclusive worldwide rights to Compound B. B has shown promising results in early testing but still requires further R&D before it can be commercialised. P will perform the R&D services required to get B approved for commercial sale, which primarily relate to testing and validating its efficacy. The R&D services required to develop B further could be performed by another pharma company.

P considers whether the licence and the R&D services are distinct and determines that:

  • the R&D services required to take B through to commercialisation are not unique or specialised − i.e. other entities could perform them;
  • the required R&D services do not have a transformative effect on the licence; and
  • P’s services do not change the nature of B.

Therefore, P concludes that the licence and the R&D services are distinct and the contract includes two performance obligations:

  • a licence; and
  • an R&D service.

However, if the nature of the R&D services provided were different such that only P could perform those services – e.g. the R&D work is highly specialised or would significantly modify B – then P may conclude that the licence for B and the R&D services were not distinct in the context of the contract and should be treated as a single performance obligation.

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Worked example – Licence for drug compound and related service: Single performance obligation

[IFRS 15.IE281–IE288]

Pharma Company P licenses its patent rights to an approved drug compound to Customer C for 10 years and promises to manufacture the drug for C. The drug is a mature product; therefore, P will not undertake any activities to support the drug, which is consistent with its customary business practices. In this case, no other entity can manufacture the drug because of the highly specialised nature of the manufacturing process.

As a result, the licence cannot be purchased separately from the manufacturing service – i.e. the licence is not capable of being distinct.

P determines that C cannot benefit from the licence without the manufacturing service. Therefore, the licence and the manufacturing service are not distinct and P accounts for them as a single performance obligation.

Conversely, if the manufacturing process used to produce the drug were not unique or specialised and other entities could also manufacture the drug for C, then P might instead conclude that C could benefit from the licence on its own and that the licence and manufacturing service were separate performance obligations.

Determine the nature of a distinct licence / Right to access IP

A licence for IP that is distinct from other goods or services in the contract is a separate performance obligation. To determine whether the performance obligation is satisfied at a point in time or over time, the entity considers whether the nature of its promise is to provide the customer with a right to:

  • access the entity’s IP throughout the licence period; or
  • use the entity’s IP as it exists at the point in time at which the licence is granted.

The revenue from a right-to-access licence is recognised over time and the revenue from a right-to-use licence is recognised at a point in time [IFRS 15.B56].

The nature of an entity’s promise in granting a licence is a promise to provide a right to access the entity’s IP if all of the following questions require a positive answer [IFRS 15.B58].

Question

Answer

1. Does the entity expect to undertake activities that significantly affect the IP?

Yes, and

One

‘No’

immediately

classifies

into:

2. Do rights directly expose the customer to positive or negative effects of the entity’s activities?

Yes, and

3. Do activities not result in the transfer of a good or service to the customer?

Yes

Conclusion

Right to access the entity’s IP

Right to use the entity’s IP

Revenue recognition

Over time

Point-in-time

To determine whether a customer could reasonably expect the entity to undertake activities that do not result in the transfer of a good or service to the customer that significantly affect the IP, the entity considers its customary business practices, published policies and specific statements, and whether there is a shared economic interest between the entity and the customer [IFRS 15.B59].

Under Question 1, an entity ‘significantly affects’ the IP when either the:

  • activities are expected to change the form (e.g. the design or content) or functionality (e.g. the ability to perform a function or task) of the IP; or Licensing of intellectual property
  • ability to obtain benefit from the IP is substantially derived from, or dependent on, those activities (e.g. the ability to benefit from a brand is often dependent on the entity’s ongoing activities to support or maintain the value of that brand) [IFRS 15.B59A].

An entity’s ongoing activities do not significantly affect the IP when the IP has significant stand-alone functionality, unless they change that functionality. IP that often has significant stand-alone functionality includes software, biological compounds or drug formulas, and completed media content (e.g. films, television shows and music recordings).

If the criteria are not met, then the nature of the licence is a right to use the entity’s IP as that IP exists at the date the licence is granted. This is because in this case the customer can direct the use of, and obtain substantially all of the remaining benefits from, the licence at the point in time when it transfers.

When the nature of the licence is a right to use the entity’s IP, it is accounted for as a performance obligation satisfied at a point in time [IFRS 15.B61]. Licensing of intellectual property

Contractual provisions relating to time, geographic region or use could represent:

  • additional licences if they create a right to use or access IP that the customer does not already control; or
  • only attributes of a promised licence to IP that the customer controls.

If these provisions do not represent multiple licences, then they are not considered when determining the nature of the entity’s promise in granting a licence (i.e. whether a right-to-use or right-to-access licence) [IFRS 15.B62].

A guarantee provided by the licensor that it has a valid patent to the underlying IP and that it will maintain and defend that patent is also not considered when determining whether the licence provides a right to access or a right to use the entity’s IP.

Worked example – Assessing the nature of a software licence with unspecified upgrades

Software Company X licenses its software application to Customer Y. Under the agreement, X will provide updates or upgrades on a when-and-if-available basis; Y can choose whether to install them. Y expects that X will undertake no other activities that will change the functionality of the software.

Although the updates and upgrades will change the functionality of the software, they are not activities considered in determining the nature of the entity’s promise in granting the licence. The activities of X to provide updates or upgrades are not considered because they transfer a promised good or service to Y – i.e. updates or upgrades are distinct from the licence.

Therefore, the software licence provides a right to use the IP that is satisfied at a point in time.

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Worked example – Assessing the nature of a film licence and the effect of marketing activities

Film Studio C grants a licence to Customer D to show a completed film. C plans to undertake significant marketing activities that it expects will affect box office receipts for the film. The marketing activities will not change the functionality of the film, but they could affect its value.

C would probably conclude that the licence provides a right to use its IP and, therefore, is transferred at a point in time. There is no expectation that C will undertake activities to change the form or functionality of the film. Because the IP has significant stand-alone functionality, C’s marketing activities do not significantly affect D’s ability to obtain benefit from the film, nor do they affect the IP available to D.

Here are 5 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – Franchise licences generally provide a right to access IP

[IFRS 15.IE289–IE296]

Franchise rights generally provide a right to access the underlying IP. This is because the franchise right is typically affected to some degree by the licensor’s activities of maintaining and building its brand. For example, the licensor generally undertakes activities to analyse changing customer preferences and enact product improvements and the customer has the right to exploit and benefit from those product improvements.

Example 57 in the standard illustrates a 10-year franchise arrangement in which the entity concludes that the licence provides access to its IP throughout the licence period.

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Food for thought – Only consider licensor’s activities that do not transfer a good or service to the customer

[IFRS 15.B58, BC410]

When evaluating the nature of its promise to provide a licence of IP, a licensor considers only activities that do not transfer a good or service to the customer.

The third criterion for a licence to be a right to access the entity’s IP is that the licensor’s activities do not transfer a good or service to the customer. If all of the activities that may significantly affect the IP transfer goods or services to the customer, then this criterion will not generally be met, resulting in point-in-time recognition.

For example, a contract that includes a software licence and a promise to provide updates to the customer’s software does not result in a conclusion that the licensor is undertaking activities that significantly affect the IP to which the customer has rights. This is because the provision of updates constitutes the transfer of an additional good or service to the customer – i.e. updates are distinct from the licence.

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Food for thought – Effect of different attributes of a licence on determining the nature of the entity’s promise

[IFRS 15.B62, BC414O–BC414R, IFRS 15.IE303–IE306]

A licence is, by its nature, a bundle of rights conveyed to a customer. The various attributes of a licence (e.g. restrictions on time, geography or use) do not affect whether the licence provides a right to use or a right to access the entity’s IP.

For example, Example 59 in the standard discusses a licence to a symphony recording that includes restrictions on time, geography and use (i.e. the licence is limited to two years in duration, permits use only in Country A and limits the customer to use of the recorded symphony only in commercials).

These restrictions are attributes of the single licence in the contract and do not affect the conclusion that the licence provides a right to use the entity’s IP. However, in certain fact patterns contractual provisions characterised as restrictions on time, geography or use may result in a conclusion that the entity has promised to grant multiple licences to the customer (see Contractual restrictions and attributes of licences).

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Food for thought – Entity’s activities that significantly affect the IP

[IFRS 15.B58, B59A]

An entity’s activities that do not transfer a good or service to the customer can significantly affect the IP to which the customer has rights when the customer’s ability to obtain benefits from the IP is substantially derived from, or dependent on, those activities. This is one of the three criteria that have to be met under IFRS to recognise revenue for a licence of IP over time.

When classifying a licence as a right to use or a right to access IP, an entity focuses on whether its ongoing activities are expected to change the licence’s form or functionality, or whether the customer’s ability to obtain benefit from the licence substantially depends on other activities of the entity that are not expected to change the form or functionality of the IP (e.g. advertising or other activities to support or maintain the value of the IP).

Revenue recognition?

Reasoning

Product/Services

Point in time

Revenue is recognised at a point in time because there is no explicit or implicit obligation for the entity to undertake activities during the licence period to

  1. change the form or functionality of the IP or
  2. support or maintain the value of the IP during the licence period.

Software

Biological compounds

Drug formulas

Copies of media content: e.g. films, television shows, music

Over time

Revenue is recognised over time because the IP’s design or functionality changes over time or because the customer’s ability to obtain benefits from the IP is substantially derived from, or dependent on, the company’s ongoing activities that will be performed over the licence period.

Brand names

Franchise rights

Logos and team names

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Food for thought – Cost and effort to undertake activities are not the focus of the analysis

[IFRS 15.IE297–IE302, BC409]

A licence is not satisfied over time solely because the entity is expected to undertake activities that significantly affect the licensed IP (the first criterion). Those activities also have to directly expose the customer to their effects (the second criterion). When the activities do not affect the customer, the entity is merely changing its own asset – and although this may affect the entity’s ability to grant future licences, it does not affect the determination of what the current licence provides to the customer or what the customer controls.

Example 58 in the standard illustrates that, when determining the nature of its promise, an entity focuses on whether its activities directly affect the IP already licensed to the customer – e.g. updated character images in a licensed comic strip – rather than the significance of the cost and effort of the entity’s ongoing activities. An entity also focuses on whether the customer’s ability to obtain benefit from the IP is substantially derived from, or dependent on, the entity’s activities (i.e. the publishing of the comic strip).

Similarly, a media company licensing completed seasons of television programmes and simultaneously working on subsequent seasons would generally conclude that the subsequent seasons do not significantly affect the IP associated with the licensed seasons, and would not focus merely on the significance of the cost or efforts involved in developing the subsequent seasons.

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Worked example – Assessing the nature of a team name and logo licence: Active sports team

Sports Team D enters into a three-year agreement to license its team name and logo to Apparel Maker M. The licence permits M to use the team name and logo on its products, including display products, and in its advertising or marketing materials.

The nature of D’s promise in this contract is to provide M with the right to access the sports team’s IP and, accordingly, revenue from the licence will be recognised over time. In reaching this conclusion, D considers all of the following facts.

  • M reasonably expects D to continue to undertake activities that support and maintain the value of the team name and logo by continuing to play games and field a competitive team throughout the licence period. These activities significantly affect the IP’s ability to provide benefit to M because the value of the team name and logo is substantially derived from, or dependent on, those ongoing activities.
  • The activities directly expose M to positive or negative effects (i.e. whether D plays games and fields a competitive team will have a direct effect on how successful M is in selling clothing featuring the team’s name and logo).
  • D’s ongoing activities do not result in the transfer of a good or a service to M as they occur (i.e. the team playing games does not transfer a good or service to M).

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Worked example – Assessing the nature of a team name and logo licence: Sports team that is no longer active

Modifying the previous example ‘Active sports team‘, Sports Team D has not played games in many years and the licensor is Brand Collector B, an entity that acquires IP such as old team or brand names and logos from defunct entities or those in financial distress. B’s business model is to license the IP, or obtain settlements from entities that use the IP without permission, without undertaking any ongoing activities to promote or support the IP.

Based on B’s customary business practices, Apparel Maker M probably does not reasonably expect B to undertake any activities to change the form of the IP or to support or maintain the IP. Therefore, B would probably conclude that the nature of its promise is to provide M with a right to use its IP as it exists at the point in time at which the licence is granted.

Something else -   What happened in the reporting period

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Worked example – Licence for right to access IP

Franchisor Y licenses the right to operate a store in a specified location to franchisee F. The store bears Y’s trade name and F will have a right to sell Y’s products for 10 years. F pays an up-front fixed fee.

The franchise contract also requires Y to maintain the brand through product improvements, marketing campaigns etc.

The licence provides F access to the IP as it exists at any point in time in the licence period. This is because:

  • Y is required to maintain the brand, which will significantly affect the IP by affecting F’s ability to obtain benefit from the brand;
  • any action by Y may have a direct positive or negative effect on F; and
  • these activities do not transfer a good or service to F.

Therefore, Y recognises the up-front fee over the 10-year franchise period.

Timing and pattern of revenue recognition

The nature of an entity’s promise in granting a licence to a customer is to provide the customer with either a right to:

A promise to provide the customer with a right to access the entity’s IP is satisfied over time because the customer simultaneously consumes and receives benefit from the entity’s performance of providing access to its IP as that performance occurs. The entity applies the general guidance for measuring progress towards the complete satisfaction of a performance obligation satisfied over time in selecting an appropriate measure of progress.

A promise to provide the customer with a right to use the entity’s IP is satisfied at a point in time. The entity applies the general guidance on performance obligations satisfied at a point in time to determine the point in time at which the licence transfers to the customer. However, revenue cannot be recognised before the beginning of the period during which the customer can use and benefit from the licence (i.e. before the start of the licence period).

An entity may enter into a contract with a customer to renew or extend an existing licence to use the entity’s IP. If the renewal is agreed before the start of the renewal period, then a question arises about when to recognise revenue for the renewal. It appears that an entity should choose an accounting policy, to be applied consistently, to recognise revenue for the renewal when:

  • the renewal is agreed: on the basis that the renewal is regarded as a modification of an existing contract in which the licence has already been delivered; or
  • the renewal period starts: on the basis that this is the date from which the customer can use and benefit from the renewal.
Worked example – Right-to-access licence

Company S enters into a contract with Customer C on 15 November Year 0 to grant C a five-year licence to its IP, with the licence period beginning on 1 January Year 1 and ending on 31 December Year 5. S provides C with a copy of the IP on 1 December Year 0. S determines that the licence provides a right to access.

Because the licence provides C with a right to access S’s IP, S will recognise the revenue from the licence over the five-year term (from 1 January Year 1 until 31 December Year 5) as it satisfies its performance obligation to provide C with access to the IP. S cannot begin to recognise revenue until 1 January Year 1 when C can begin to use and benefit from the licence.

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Worked example – Right-to-use licence

Modifying the above example Right-to-access licence, assume that the licence provides Customer C with a right to use Company S’s IP.

Because the licence provides a right to use its IP, S recognises the revenue from the licence at a point in time on 1 January Year 1. This date is the first point in time at which C:

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Worked example – Renewal of a right-to-use licence

Company S enters into a contract with Customer C on 1 January Year 0 to grant C a three-year licence to its IP for consideration of 100. The licence period is from 1 January Year 1 to 31 December Year 3. S determines that the licence provides a right to use and recognises the revenue from the licence at a point in time on 1 January Year 1, when C obtains control of the licence and is able to use and benefit from the licence.

On 1 January Year 3, S and C agree and approve a renewal of the licence for a further three-year period for consideration of 100 payable at the date of the agreement. There are no other changes to the licence (i.e. the other terms and conditions of the licence and the IP remain the same). The renewal period is from 1 January Year 4 to 31 December Year 6.

S should choose an accounting policy, to be applied consistently, to recognise 100 revenue for the renewal on 1 January Year 3 (i.e. when the renewal is agreed) or 1 January Year 4 (i.e. when the renewal period starts).

Here is 1 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – Application of the general guidance on performance obligations satisfied at a point in time

[IFRS 15.38]

IFRS 15 states that a right-of-use licence is satisfied at a point in time and that the indicators for determining when control transfers generally apply (see Performance obligations satisfied at a point in time). However, for licences of IP that are a right of use, the standard adds an additional requirement that revenue cannot be recognised before the beginning of the period in which the customer can begin to use and benefit from the licence.

Although the point at which the customer can begin to use and benefit from the licence will typically be readily determinable, the point-in-time transfer of control indicators may not be applied to licences as easily as they might be to physical goods. For example, there may not be ‘legal title’ to a licence and it may be difficult to assess whether the customer has the significant risks and rewards of a licence.

However, the contract can be viewed as analogous to title to a licence and availability of a copy of the IP (when applicable) as the equivalent of ‘physical possession’. Assessing the entity’s right to payment in a licence contract should not be significantly different from that assessment in other scenarios.

Consequently, control of a licence will generally transfer to the customer when:

  • there is a valid contract between the parties;
  • the customer has a copy or the ability to obtain a copy of the IP; and
  • the customer can begin to use and benefit from the licence.

Contractual restrictions and attributes of licences

The following factors are not considered when determining the nature of the entity’s promise in granting a licence:

  • restrictions of time, geography or use of the licence; and
  • guarantees provided by the licensor that it has a valid patent to the underlying IP and that it will maintain and defend that patent [IFRS 15.B62].

Here are two examples that qualify respective not qualify, a great learning moment: analyse the key differences in each case:

Worked example – Licence of IP: Hold-back period

On 1 January Year 1, Film Studio F enters into a three-year contract to grant Broadcaster B the exclusive right to air Film M in the US and Canada during the contract term. B has the right to air M in the US immediately but, due to an overlapping contract with a Canadian competitor, the rights to air the film in Canada do not begin until 1 July Year 1 – i.e. there is a six-month hold-back period.

F considers whether the contract grants B a single licence that is subject to a use restriction (i.e. a single licence to show the film in the US from 1 January Year 1 and in Canada from 1 July Year 1), or two licences (i.e. one licence to show the film in the US and one licence to show the film in Canada).

F determines that the contract includes two promised licences based on the following:

  • the term of the contract preventing B from airing the film in Canada for the first six months of the contract term leads to the rights to show the film in Canada being a separate and additional right transferred on 1 July Year 1; and
  • B does not control the additional right at 1 January Year 1 because it cannot use and benefit from it in Canada before 1 July Year 1. This differentiates it from the right to show the film in the US.

Therefore, the right to air the film in Canada represents a separate promise that F has not yet transferred to B.

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Worked example – Licence of IP: Usage limitations

Modifying the aforementioned worked example Licence of IP: Hold-back period, the rights to air Film M in the US and Canada both start on 1 January Year 1. However, the terms of B’s rights to air the film extend only to eight broadcasts in each territory during the three-year period and, as part of the contract, B agrees not to air certain types of adverts during the film.

In this case, F determines that the contract is for a single licence because B can begin to use and benefit from the rights conveyed in both the US and Canada from 1 January Year 1. There are no additional rights transferred after 1 January Year 1.

The term of the licence (three years), the geographic scope of the licence (B’s US and Canadian networks only) and the usage limitations (limited to eight showings per territory and restrictions on adverts during the film) are all attributes of the licence.

Here are 3 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – No explicit guidance on distinguishing attributes of a licence from additional licences

[IFRS 15.IE304, BC414O–BC414R]

The standard does not include explicit guidance on distinguishing attributes of a licence from additional licences, so judgement is required to determine when a restriction creates multiple licences and when it is an attribute of the licence.

The basis for conclusions notes that an entity considers all of the terms in a contract when considering whether promised rights result in the transfer of one or more licences to the customer.

This judgement is necessary to distinguish between contractual provisions that create promises to transfer rights to use the entity’s IP from contractual provisions that establish when, where and how those rights may be used.

Example 59 of the standard illustrates that restrictions of time, geography and use are considered as attributes of a single licence in a contract.

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Food for thought – Distinguishing attributes of a single licence from additional promises to transfer licences

A provision in a contract that requires the entity to transfer additional rights to use or access IP that the customer does not already control generally describes an additional promise for the entity to fulfil.

In worked example – Licence of IP: Hold-back period above, the provision restricting the customer’s ability to use the IP in Canada initially means that, until those rights start, the entity has a remaining obligation to transfer those rights that the customer does not already control.

Because of that provision, the contract in  worked example – Licence of IP: Hold-back period could easily have been written as a contract to grant two distinct licences (one to air Film M in the US and a second licence to air M in Canada). The accounting outcome in a scenario such as  worked example – Licence of IP: Hold-back period does not depend on how the contract is written.

In contrast, in worked example – Licence of IP: Usage limitations above illustrates that licences are, by nature, a bundle of rights to IP that are often limited in duration and scope (geographic and usage).

The provisions describing the duration and scope of the customer’s rights in Example 13B are distinguished from the requirement in  worked example – Licence of IP: Hold-back period that the entity transfer additional rights after some other rights have been transferred (i.e. to fulfil a remaining promise to transfer those additional rights).

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Food for thought – Substantial break between periods during which a customer is able to use (or access) IP

In some cases, a substantial break between periods during which a customer is able to use (or access) IP might suggest that those two separate periods of time represent separate licences, even if the rights conveyed during each period are the same. This scenario arises principally in the media industry and is often referred to as a ‘broken windows’ scenario. The facts and circumstances will need to be considered when deciding whether broken windows should be accounted for as a single licence or multiple licences.

Sales- or usage-based royalties

For sales- or usage-based royalties that are attributable to a licence of IP, the amount is recognised at the later of:

  • when the subsequent sale or usage occurs; and
  • the satisfaction or partial satisfaction of the performance obligation to which some or all of the sales- or usage-based royalty has been allocated [IFRS 15.B63].

This is an exception to the general requirements and it applies when the:

  • royalty relates only to a licence of IP; or
  • licence is the predominant item to which the royalty relates (e.g. when the customer would ascribe significantly more value to the licence than to the other goods or services to which the royalty relates) [IFRS 15.B63A–B63B].

An entity does not split a royalty into a portion that is subject to the exception and a portion that is subject to the guidance on variable consideration, including the constraint (see Variable consideration (ant the constraint)).

If the exception does not apply, then the entity applies the general guidance on variable consideration, including the constraint, to the royalty arrangement and includes its estimate in the transaction price.

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Worked example – Royalty: Licence of IP is the predominant item

Film Distributor D licenses the right to show a film in cinemas for six weeks to Film Company T. D has agreed to provide memorabilia to T for display at cinemas and to sponsor radio adverts. In exchange, D will receive a royalty equal to 30% of the ticket sales.

D has a reasonable expectation that T would ascribe significantly more value to the licence than to the related promotional activities, and therefore D concludes that the licence to show the film is the predominant item to which the sales-based royalty relates.

D applies the royalties exception to the entire sales-based royalty and therefore cannot recognise revenue when the promotional activities are provided based on an estimate of the expected royalty amount.

If the licence, the memorabilia and the advertising activities were separate performance obligations, then D would allocate the sales-based royalties to each performance obligation when or as the subsequent sales occurred.

Then it would recognise the royalties allocated to each performance obligation based on whether that performance obligation has been satisfied – e.g. whether the licence, which is a right to use IP in this example, has been transferred to the customer or whether the advertising services are complete.

Here are 8 things to keep in mind when assessing the IFRS reporting of licensing of intellectual property:

Food for thought – Exception for sales- or usage-based royalties aligns the accounting for different licence types

A key practical effect of the exception for sales- or usage-based royalties is that it may reduce the significance of the distinction between the two types of licences in certain circumstances. In particular, if the consideration for a licence consists solely of a flat sales- or usage-based royalty for a distinct licence, then an entity is likely to recognise it in the same, or a substantially similar, pattern, irrespective of whether the licence provides the customer with a right to access IP or a right to use IP.

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Food for thought – Judgement is required to assess when a licence of IP is ‘predominant’

[IFRS 15.B63A]

An entity may be entitled to a sales-based or usage-based royalty in exchange for a licence and other goods or services in the contract, which may or may not be distinct from the licence. Licences of IP are often bundled with other goods or services, with the consideration taking the form of a sales- or usage-based royalty for all goods or services in the contract. For example:

  • software licences are commonly sold with PCs and other services (e.g. implementation services) or hardware where there is a single consideration in the form of a sales- or usage-based royalty;
  • franchise licences are frequently sold with consulting or training services or equipment, with ongoing consideration in the form of a sales-based royalty;
  • biotechnology and pharmaceutical licences are often sold with R&D services and/or a promise to manufacture the drug for the customer, with a single consideration in the form of a sales-based royalty; or
  • licences for digital media and a promise for promotional activities may be sold with a single consideration in the form of a sales-based royalty.

The guidance specifies that the royalties exception applies when the licence is the predominant item to which the royalty relates. ‘Predominant’ is not defined. However, the standard says that “this may be the case when the customer would ascribe significantly more value to the licence than to the other goods or services to which the royalty relates”.

Significant judgement may be required to determine whether a licence is the predominant item in an arrangement. For example, an entity may determine that a licence of IP is the predominant item when it represents the major part or substantially all of the value or utility of the bundle.

Another entity may conclude that the exception would apply when a licence of IP is the largest single item in a bundle of goods or services. These different interpretations could result in differences in practice and may give rise to differences in the transaction price and timing of revenue recognition, because they could affect the conclusion on whether the royalties exception applies to an arrangement.

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Food for thought – Application of royalties exception to milestone payments

Company X enters into a contract to licence IP to Company Y. In exchange for the licence, X is entitled to a 5 million milestone payment after Y has reached 50 million in sales.

The royalties exception generally applies to the milestone payment because the payment is based on Y’s subsequent sales. Consequently, X does not recognise any revenue for the variable amount until the subsequent sales occur. However, this view does not extend to milestone payments that are determined with reference to other events or indicators – e.g. regulatory approval or enrolment in clinical trials.

For example, arrangements in the life sciences industry often include a licence of IP of a drug and an obligation to perform R&D services, with a substantial portion of the fee being contingent on achieving milestones such as regulatory approval of the drug.

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Food for thought – Guaranteed minimum payment – Right-to-use licence

For a right-to-use licence, any guaranteed minimum payment represents fixed consideration – i.e. it is an amount payable by the customer that will not vary based on sales, usage or any other metric. This fixed amount is recognised as revenue at the point in time when the customer obtains control of the licence.

Royalties earned in excess of the guaranteed minimum are recognised as and when the related sales or usage occurs.

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Food for thought – Guaranteed minimum payment – Right-to-access licence

The standard does not prescribe a single approach for recognising revenue for a right-to-access licence when the contract includes royalties with a minimum guarantee. Instead, an entity chooses an approach that appropriately considers all of the principles in the standard, including the royalty exception, selecting measures of progress and the variable consideration allocation exception.

One acceptable approach is illustrated in worked example – Software licence with a guaranteed minimum (2) below.

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Food for thought – Variable royalty rates – Right-to-use licence

An entity recognises revenue from a sales- or usage-based royalty when (or as) the customer’s subsequent sales or usage occurs unless this method would accelerate the recognition ahead of the entity’s performance in completing the performance obligations. Therefore, when the royalty relates to a right-to-use licence, it is generally recognised as and when sales or usage occur because performance is complete.

One exception to this approach is when a declining rate is applied on a retrospective basis – e.g. customers receive a refund or credit on previous payments when the customer reaches a lower royalty rate. In these cases, the entity estimates the ultimate royalty rate that it expects to be entitled to and applies that to the sales or usage. The entity updates that estimate over the licence term.

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Food for thought – Variable royalty rates – Right-to-access licence

An entity recognises revenue from a sales- or usage-based royalty when (or as) the customer’s subsequent sales or usage occur unless this method would accelerate the recognition ahead of the entity’s performance in completing the performance obligations. Therefore, when the royalty decreases over the licence term an entity evaluates whether a portion of the royalty rate needs to be deferred to ensure that the entity does not recognise revenue ahead of its performance.

Conversely, when the royalty rate increases over the licence term the entity generally recognises revenue at the current royalty rate because an entity cannot recognise revenue before sales or usage occurs.

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Food for thought – Allocating sales- or usage-based royalties to multiple performance obligations

An entity may enter into a contract with multiple performance obligations that consist of a licence of IP and another good or service that is transferred over a different time period. If the requirements to allocate variable consideration entirely to one performance obligation are not met, then an entity allocates the sales- or usage-based royalties to multiple performance obligations.

The standard is not clear about how an entity allocates the consideration to its performance obligations when the contract includes sales- or usage-based royalties predominantly associated with a licence of IP and a guaranteed minimum. Multiple approaches could be acceptable if they are consistent with the allocation objective and application of the royalty exception. The following are examples of acceptable approaches.

  • Approach 1: Allocate the fixed consideration and variable consideration separately based on relative stand-alone selling prices.
  • Approach 2: Estimate the total transaction price (including royalties) and allocate that amount to each performance obligation subject to a cumulative recognition constraint.

Additional application examples

To further exemplify the requirements in licensing of intellectual property here some examples of application of these requirements:

Worked example – Software licence with a guaranteed minimum (1)

Company M enters into a five-year arrangement to license software to Customer C. The software licence provides C with the right to use M’s software – i.e. revenue is recognised at a point in time. The consideration for the licence is a sales-based royalty of 5% of C’s gross sales of products that include M’s software, with a minimum guaranteed amount of 5,000.

The 5,000 guaranteed royalty amount is fixed consideration and is recognised in the same manner as any other fixed consideration – i.e. as revenue when the customer obtains control of the licence. Any royalties in excess of the minimum guaranteed amount are recognised when C’s subsequent sales – i.e. those above the minimum – occur.

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Worked example – Software licence with a guaranteed minimum (2)

Modifying worked example – Software licence with a guaranteed minimum (1), the software licence provides C with a right to access M’s IP and revenue is recognised over time.

M determines that the guaranteed minimum is substantive and that it is appropriate to recognise the guaranteed minimum amount on a straight-line basis over the licence period. M recognises any royalty amounts above the guaranteed minimum only after the guaranteed minimum of 5,000 has been exceeded. However, other methods may also be appropriate, as long as a single measure of progress is used for the performance obligation.

Conversely, if the guaranteed minimum is considered non-substantive then M recognises revenue as and when sales occur.

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Worked example – Allocation of guaranteed minimum among multiple performance obligations

Tech Company T enters into a three-year arrangement to license its technology to Customer C along with a promise to provide when-and-if-available upgrades developed during the licence term.

T concludes that the licence and promise to provide when-and-if-available upgrades are two distinct performance obligations.

T receives a royalty of 10% of C’s sales subject to a minimum guaranteed amount of 10,000. T estimates that the total consideration (fixed plus variable) will be 50,000.

T estimates the stand-alone selling price of the licence and when-and-if-available upgrades to be 15,000 and 35,000, respectively. T concludes that the royalty is predominantly associated with a licence of IP because both performance obligations are related to providing IP.

C’s gross sales and the related royalties earned each year are as follows. This information is not known at the beginning of the contract.

Licensing of intellectual property

Approach 1: Allocate fixed and variable consideration separately

T allocates the fixed fee (guaranteed minimum) of 10,000 on a relative stand-alone selling price basis.

Licensing of intellectual property

T allocates the estimated variable royalty (in excess of the minimum) of 40,000 between the two performance obligations on a relative stand-alone selling price basis as future usage and sales occur.

T recognises the variable amounts allocated to the when-and-if-available upgrades in the period the amounts are earned because the performance obligation is a series of distinct time periods and T meets the criteria to allocate the fees directly to the distinct periods in which the sales occur as follows:

  • the fees relate to the customer’s past usage and the licence and when-and-if-available upgrades; and
  • the allocation is consistent with the allocation objective because the fee is consistent from period to period and C’s greater usage reflects additional value to C (see Allocate the transaction price).

The following table summarises the allocation and recognition for each performance obligation during the three-year contract term.

Licensing of intellectual property

Notes

  1. 10,000 minimum × 30% allocation. This amount is recognised immediately on transfer of the licence because it is a right-to-use licence recognised at a point in time.
  2. 10,000 minimum × 70% allocation × 1/3 complete. Only a portion is recognised each period because this amount is recognised over time.
  3. 5,000 royalty above the minimum (15,000 – 10,000) × 30% allocation.
  4. 5,000 royalty above the minimum (15,000 – 10,000) × 70% allocation.
  5. 25,000 additional royalty × 30% allocation.
  6. 25,000 additional royalty × 70% allocation.
  7. 10,000 additional royalty × 30% allocation.
  8. 10,000 additional royalty × 70% allocation.

Approach 2: Allocate fixed and variable consideration together

T allocates the 50,000 estimated transaction price on a relative stand-alone selling price basis as follows:

  • 15,000 to the licence; and
  • 35,000 to the when-and-if-available upgrades.

When (or as) the performance obligations are satisfied, T recognises as revenue the lesser of the amount allocated to the performance obligations satisfied or the amount that is no longer subject to the royalty constraint.

Licensing of intellectual property

Notes

  1. The right-to-use licence is transferred at a point in time. As such, the performance obligation is satisfied on transfer and the amount allocated to that performance obligation is 15,000.
  2. There is a guaranteed minimum of10,000 in the contract.
  3. 35,000 allocated to the upgrades / 3 years.
  4. 15,000 in royalties earned during Year 1 – 10,000 minimum already recorded.
  5. 25,000 additional royalties earned during Year 2.
  6. 10,000 additional royalties earned during Year 3.

 

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